Magic of Compound Interest

The Rule of 72
Have you always wanted to be able to do compound interest problems in
your head? Well, let's be honest - probably not.

However, it's a very useful skill to
have because it gives you a lightning fast benchmark to determine how
good (or not so good) a potential mortgage note (or any investment) is
likely to be. And it's surprisingly easy to do in your head... once you
know how.

The rule says, that to find the number
of years required to double your money at a given interest rate, you simply
divide the interest rate into 72. That's why it's called the "Rule
of 72"!

For example, if you want to know how
long it will take to double your money at 8% interest, you would simply
divide 8 into 72 and you'll get 9 years. This is assuming the interest
is compounded annually.

As you can see, the "rule" is remarkably
accurate, as long as the interest rate is less than about 20%. At higher
interest rates the error starts to become significant.

Of course, you can also run it backwards.
For example if you want to double your money in 6 years, just divide 6
into 72 to find that it will require an interest rate of about 12%.

Quite easy! You don't need to be a "math-whiz"
to do it. Now, let's continue this fascination subject with some fun exercises.

Famous Compounding
HistoryThe history of compounding computation goes
back thousands of years, at least to the Babylonians.

However, the most famous compounding
exercise of the all has to be the sale of the Island of Manhattan in NY
in 1626.

It was May 24, 1626 when Peter Minuit,
a director of the Dutch West India Trading Company, bartered sixty guilders
(about $24) worth of beads and trinkets to local Lenape Indians in exchange
for the island of Manhattan. There is some doubt that actual beads were
involved in the transaction, but that's another story.

It's too bad, but no deed or official
document of the island's sale to the Dutch from the Lenape Indians exists
today.

Now, an interesting investment question
arises...

Was this a good deal for Minuit
or not?

Let's look at the deal. What would be
the value of $24 if Minuit had invested it instead at 8% interest, compounded
annually for 374 years? (1626-2000)?

At first sight, this seems like the deal
of the century. Given today's real estate values in New York, this appears
to be a great deal for Minuit. But not so fast... remember, you always
have to do the numbers!

Now, if you run the numbers, you'll discover
that the original $24 would have grown to a staggering...

$76 Trillion!

Yes, you read it right, not million,
not billion, but trillion.

This is actually more that the estimated
value in today's dollars of all the real estate on this 31 square
mile island.

So which would have been the better investment?

The Magic of Compound
Interest Let's continue for some more fun. Imagine
that back in 1930 your grandparents scrimped and saved and placed $100
in a trust fund where the money would accumulate for their grandchild
(you).

And imagine that the $100 remained in
this fund for some 70 years, until the year 2000, earning the average
rate of 12%. How much money would you think you would have today from
that initial $100 investment?

The answer, incredible as it may sound,
is...

$278,780!

Remember, we're only talking
about a single $100 investment, not $100 added per month
or per year!

Of course it might have been hard to
get 12% year-after-year, some years would have been a lot less. But then
again, remember the early 1980's, when it was not uncommon to get 15-18%
interest on your money.

Just imagine if your grandparents and
your parents had also added just small amounts of money every year to
your fund, how much money you would now have!

Here's How Compounding
WorksCompound interest pays interest not
only on the principal, but on the interest as well, increasing
the rate at which your money grows.

For example if the interest was compounded
yearly and you started with a $100 investment at a 10% interest rate,
you'd have earned $10 interest the first year, and would now have $110
at the end of the first year.

In the second year, you would earn interest
on $110, giving you $11 in interest in the second year, so at the end
of the second year you would now have $121, and so on. So after 20 years
you'd end up with $672.75!

Add Payments for Even
Greater GrowthNow, if you'd added additional money to
your savings every year your money would of course grow even faster.

For example, if you save $2,000 a year
at 10% interest, you'll have more than $35,000 after 10 years.

Not bad, but... if you keep at it another
10 years, (double the initial period) you'll have far more than $70,000,
(double the $35,000).

In fact you'll have $126,000!

Go for another 10 years and you'll accumulate
about $362,000. Another 10 - that would be 40 years or a typical "working''
lifetime - and you'll be... are you ready for this...

Almost a Millionaire - with $973,703.62!

Generally, any series of regular or steady
payments is called an annuity .

Now, you might wonder what does all this
have to do with mortgage notes?

Well, you have to wait until next time,
when I'll show you how you can actually lower the interest
rate on a note or a loan and still come out ahead...

Way Ahead!

Remember...

"You Don't Have To Get It Perfect...
You Just Have To Get It going!"

About the Author

Article by Theodore Hansson of Theodore
Hansson Co. Theodore has helped 1000's of ordinary people succeed in
their own home-based business, brokering loans. Visit him at
http://www.thansson.com
for FREE "how-to" information as well as a free subscription
to his newsletter "Loan Brokering Tips & Tricks".